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When building more homes isn't enough in the UK

When we published our revised market forecasts earlier this summer, we nudged upwards our prediction for the number of property transactions this year. But this does not presage any significant increase in mortgage-funded purchases, with lending set to grow this year by only a modest 3%. Recently, we have seen a large number of cash purchases, which have accounted for as many as 37% of all transactions. They will help boost the overall number of purchases this year to a little over 1.2 million.

Looking back at the aftermath of the financial crisis – when transactions were languishing below 900,000 a year – that looks like a healthy recovery. But is it really? Go back further, and we can see that current transaction numbers are no higher than they were in the mid-1990s – a period when activity was depressed by a large number of home-owners caught in negative equity.

Given that, since then, the size of the UK’s housing stock has increased by a third, it makes current levels of market activity look decidedly sluggish.

Credit crunch ‘only part of the problem’

It’s tempting to say that we are still recovering from the effects of the credit crunch. And while that’s true, a range of deep-seated and inter-related problems in the housing market is holding back a recovery in transactions. They present fundamental and long-term challenges, and will not easily be solved.

Demographic changes are simultaneously boosting demand for housing and constricting its supply. It is clearly understood that net migration, increasing life expectancy and the growth in the number of single-person households are all boosting demand. But we also have an ageing population that holds a disproportionately large amount of national housing assets. Older people are more likely to under-occupy housing, and to be reluctant – or unable – to move to homes that might better suit their needs.

Demand for rental property increases because property prices continue to outstrip earnings, and would-be first-time buyers have no housing equity growth to draw upon (unless it is held by their parents). So, although young people continue to aspire to be home-owners in the long run, the rising house price-to-earnings ratio often reinforces current lifestyle preferences for renting.

Landlords have helped improve the supply of rental property, but they also have other effects on the market. With only a relatively small amount of newly-built property intended for the rental market, much of the increased supply of private rented property simply re-badges existing stock. Meanwhile, landlords tend to expand their portfolios and therefore do not release much property back to the market for owner-occupiers. But, as we said earlier in News & Views opinion, there is a risk that buy-to-let landlords, in particular, end up taking the rap for a failure of housing supply. We must not forget that buy-to-let is recovering from a much bigger post-crash slump than we saw in the owner-occupied market.

Helpfully, government policy often focuses on encouraging new housing construction, and this is essential (although not sufficient) in helping deliver a long-term solution. But we should not forget that the vast majority of housing supply in any period comes from those selling existing stock. Promoting more activity across the market as a whole may help to encourage both more efficient use of existing housing and the marketability of new homes.

In particular, the government should not forget that taxation plays an important role in influencing liquidity in the property market and the efficient use of housing. Recent reforms may have improved the structure of stamp duty by removing some its price distorting effects, but it is difficult to disagree with the Institute for Fiscal Studies that these reforms have transformed stamp duty from a “very bad” tax into merely a “bad” one.

As a result of these factors, we now have a dysfunctional housing market, beset by long-term structural problems that are difficult to address.

There is a growing mismatch between housing demand and supply, which is unlikely to be resolved by a fixation on new-build activity alone.

This is made worse by a secular decline in housing market turnover and liquidity.

Poor turnover reinforces inefficient use of the housing stock.

Home-ownership is becoming increasingly polarised – by such parameters as age and the tenure of parents. Is a healthy property market one that is increasingly driven by older property owners providing a key to a home for their children by tapping into their own housing equity?

Property prices look set to remain stretched relative to incomes because of the long-term imbalance between supply and demand. Over the last 15 years or so, the widening gap between house prices and earnings has been exacerbated by low inflation and interest rates.

Chart 1: The relationship between house prices and earnings

Even though deposit constraints have eased since the crash, and the availability of mortgage credit has partially recovered, the volume of property transactions remains stubbornly low by pre-crash standards – despite growth in the stock of homes.

An incomplete strategy

Over and above this, regulated house purchase activity has shrunk relative to the market overall, with movers showing only a limited recovery. Regulatory reforms are reinforcing a conservative trajectory for mortgage lending, so that recovery in the wider economy looks set to prompt only a weak pick-up in housing market activity.

While new and re-invigorated government policies may stimulate housing market activity to some extent, the almost exclusive focus on boosting new construction seems an incomplete strategy for delivering a sustainable and healthy housing market.

Even if government policy helps to deliver the 250,000 or so homes needed in England (and 300,000 in the UK as a whole) over the next decade, 90% or more of the housing stock that will exist in 2025 has already been built, and is being lived in by somebody. Government measures that nudge towards better use of the current stock could contribute materially to the supply-demand picture.